Chain is improving customer relations, but a comeback still is in question By Staff Writer John Chartier

NEW YORK (CNNfn) - Walk into a Kmart store these days and the changes are evident – cleaner aisles, neater, stocked shelves, more associates on the floor and faster checkout times.

Investors have rewarded the nation's No. 2 discount chain and new CEO Chuck Conaway by snapping up shares, sending the stock to a new 52-week high of $13.55. That's well above the $4.75 low it reached earlier this year.

Kmart's operations are improving, but fierce competition could hamper a comeback (CNN/FILE)

Meeting fourth-quarter targets could be tricky as consumers, pinched by the slowing economy, increasingly turn to lower-priced goods that carry low margins, which is good for sales but bad for profit.

Investors will be watching when Kmart (KM: down $0.22 to $12.10, Research, Estimates) reports its second-quarter results before the opening bell Thursday. Analysts polled by earnings tracker First Call anticipate a loss of 4 cents a share, compared with a profit of 5 cents a share a year earlier.

Analysts project Kmart's earnings to hit 60 cents a share for the fourth-quarter, which includes the crucial holiday season, and 48 cents a share for the full year, compared with 47 cents a share in 2000.

And sales at its Internet unit, Bluelight.com, could be like an elephant on its back. The company recently folded the independent unit back into the parent, since it did not drive the hoped-for results.

But Wal-Mart and Target already have reported more lackluster results than many had forecast.

"We're all sitting here waiting for this company to produce earnings from the changes Chuck Conaway has initiated. These changes are going to make a substantive difference. The market believes it. We do too. But it won't start being reflected until we see the hard numbers," Ladenburg Thalmann & Co. retail analyst Eric Beder said.

Discount chains have weathered this latest economic slowdown better than other types of retailers as price-conscious consumers, wary of layoffs, high energy prices and a volatile stock market, shift away from higher-priced department stores and specialty chains.

So discount chains are fighting for a piece of the sudden market share in hopes they will retain it once the economy recovers.

Additionally, several mass merchandise chains such as Caldor, Montgomery Ward and Bradlees have succumbed to the tough environment and gone out of business, meaning there are fewer players fighting for new customers.

"Let's face it, there is ongoing consolidation between channels where discounters are by and large taking marketing share from department stores and food retailers," said one analyst who asked not to be identified.

Kmart is struggling to remain a player, and 43-year-old Conaway has made great strides in improving relationships with customers and suppliers and improving the efficiency of the stores.

"I think to be honest, we are much happier with the new leadership at Kmart," said Gary Knell, CEO of Sesame Workshop, the non-profit group that produces the Sesame Street children's program. Kmart holds the exclusive license to Sesame Street apparel and is Sesame's third largest licensee.

"I think generally the store might have lost its way somewhat in the early days," Knell said. "I think what Chuck Conaway has tried to do is get at the core of what their consumer is all about. He's building relationships with the consumer, building a more personal experience in the store, which is something they really didn't ever have."

For years, Kmart languished as the popularity of its hourly "blue light" specials waned with the growth of competitors such as Wal-Mart and department store chains.

I think what Chuck Conaway has tried to do is get at the core of what their consumer is all about. He's building relationships with the consumer, building a more personal experience in the store, which is something they really didn't ever have

Gary KnellCEOSesame Workshop

The children of a generation that shopped there began to shun the store as it evoked stale images of cheap goods. Throughout the 1970s and 1980s, stores were packed with heavily discounted items that hurt profit margins and drove up costs as the inventory began to pile up.

Stores became messy, customer service waned and checkout times climbed.

Then Floyd Hall came along. In the early to mid 1990s, Hall revived the struggling company, designing the Super Kmart store concept and launching a major advertising/marketing campaign featuring popular television spots with the celebrity duo of Penny Marshall and Rosie O'Donnell.

It was also during Hall's watch that the company struck an important licensing agreement with style maven Martha Stewart, whose items for the home designed for Kmart quickly exceeded $1 billion in sales and continue to be top sellers.

"The only reason the company's alive is that Kmart has the best stable of licensed brands," Beder said.

But again, the company's old image came back to haunt it and the surge did not last. Pressure from the likes of Wal-Mart, Target, Kohl's J.C. Penney (JCP: down $1.33 to $25.05, Research, Estimates) and other companies chipped away at Kmart's market share.

The only reason the company's alive is that Kmart has the best stable of licensed brands

Eric BederRetail AnalystLadenburg Thalmann & Co.

In May 2000, Kmart thanked Hall for his efforts and replaced him with Conaway. The former chief of No. 2 drugstore chain CVS Corp. breezed in and immediately laid out a recovery plan that investors and the Street latched onto.

Last July Conaway shuttered more than 70 underperforming stores and announced a major restructuring plan in which Kmart would invest in new customer check-out and inventory management technology and systems. That, he said, would free up sales associates to spend more time assisting customers.

He personally visited the stores and initiated an internal customer satisfaction index by which to gauge the company's performance. Store shelves would be stocked, aisles would be clean and neat, and checkout lines would move faster.

Additionally, Conaway revived the once popular blue light special. Instead of the old method of clearing out cheap inventory, the new blue light special focuses on deals for everyday items and a broader "blue light always" program offers everyday low prices on certain items.

Kmart also has introduced an in-store grocery concept called The Pantry, which so far has proven successful. It entered a multi-year partnership with food supplier Fleming Cos. and has plans to expand the concept until it offers a complete grocery selection in order to better compete with Wal-Mart, analysts said.

But there's still a way to go. The company's prices remain higher than Wal-Mart and Target's even though it is a discount chain.

In an effort to bridge that gap, Kmart has started aggressively pricing certain items. This has drawn the ire of competitors who are fearful that the company could endanger the entire discount sector by initiating a price war.

On Tuesday, Target sued Kmart, alleging that the company's "Dare to Compare" advertising campaign inaccurately compares its own prices with those of Target a majority of the time on in-store signs.

"I think Kmart is stretching and trying to come up with ways to revitalize sales and earnings growth, and they've gone out with these very aggressive statements in their in-store advertising, which Target is willing to call them on," said one analyst who asked not to be identified.

Investors are happy with the changes taking place, but analysts caution that Kmart still has many things to do before its turnaround is complete. Its blue light always program is a success, but analysts said it needs to be expanded, since Kmart so far is unable to compete with Wal-Mart's everyday low price initiative.